8/26/2009 @ 6:49PM

Obama Mortgage Effort May Need Modification

In a sign that the Obama administration’s plan to stem foreclosures needs retooling, one of the main reasons struggling mortgage borrowers are being turned away from the Home Affordable Modification Program is that their mortgages are, by its standards, too affordable.

In order to make the president’s $75 billion loan modification initiative easy for servicers to implement and for borrowers to understand, eligibility is primarily based on the ratio of a borrower’s mortgage payment to their income. If the mortgage requires more than 31% of their paycheck, the loan is considered “unaffordable” and the borrower is in, provided they meet other criteria. If it’s less, which is the case for many, they are out of luck.

Loan servicers criticize the formula as too narrow, saying it doesn’t take into account other debts that borrowers have racked up.

William Erbey, chief executive of Ocwen, the second-largest U.S. subprime mortgage servicer, says his borrowers are often saddled with credit card bills and auto loans and will pay those bills before their home loans. “It’s not their mortgage that is out of whack. It’s that their other consumption patterns are out of whack,” Erbey says.

CitiMortgage, which services one in 10 mortgages in the U.S., says the formula is also the leading reason it has excluded borrowers from the program. Chief Executive Sanjiv Das chided policymakers for ignoring why many borrowers are falling behind. “This is people solving for a housing crisis not realizing we’re in a credit crisis,” he says.

Six months after HAMP was launched, the government reported earlier this month that only 235,000 borrowers had been enrolled. The Obama administration is pressuring servicers to ramp up modifications to meet its goal of 4 million taxpayer-sponsored workouts. (See “Weak Progress On Loan Modifications.”) The slow pace of progress and obvious kinks in the program, like the rigid affordability formula, suggest the program itself is ready for a modification.

The financial incentives for servicers to participate are appealing: “Most servicers want to do the HAMP program because we get paid [to do it],” said Ocwen’s Erbey. Nonetheless, mortgage companies are cooking up their own versions of mortgage relief. They churned out 1.5 million of their own in-house designed modifications during the first half of the year, according to HOPE NOW, an industry-led foreclosure mitigation group.

Foreclosures were initially fueled by irresponsible lending to unqualified buyers, but rising unemployment, which was running at 9.4% in July, has begun to drive more borrowers under. During other downturns, many jobless homeowners were able to sell their homes at a profit, avoiding foreclosure. But since real estate values have plunged nationally by one-third from their 2006 peak, roughly one in three mortgages owe more on their homes than they are currently worth, according to First American CoreLogic, a real estate data firm.

Since taking over the
Citigroup
mortgage subsidiary a year ago, Das has pioneered one of the few programs aimed at helping borrowers who are unable to pay their mortgage due to unemployment. The program has helped only a handful of borrowers, about 600, but Das says he has been in discussions with Treasury to expand it to reach more people. “The subprime phenomena has been flushed out,” Das says. “You’ve got to innovate around the problems of today.”

In February, economists at the Boston Federal Reserve Bank proposed a plan under which unemployed mortgage borrowers would receive aid from taxpayers equal to half their former income for up to two years. “It would have definitely prevented foreclosures,” says Paul Willen, one of the authors of the proposal, “and it’s not that complicated to implement.” (See “America’s New Housing Problem: Unemployment.”)

A Treasury Department spokesman says, “The administration is considering many ideas as part of our ongoing efforts to relieve struggling homeowners and stabilize the housing market. No decisions have been made on this matter.”

As the administration continues to pressure servicers to increase their government workouts, some analysts worry that there’s nothing in the way the HAMP program is designed, other than intensive oversight, to prevent servicers who modify lots of borrowers who don’t really need it.

“Measuring the success of the modification program based on re-default is risky because it encourages servicers to find the loans that are most likely to remain current,” says the Boston Fed’s Willen. “They will end up modifying 4 million loans to look like they’re doing something, and it will not make a big dent in the number of foreclosures.”